In part one, we looked at the ranges of different sector VIXs, compared the S&P VIX to a similar past time-frame during a mid-term election cycle, examined the current VIX futures contango structure, and did some rough calculations of negative roll yield in the current structure. Now we want to examine some trade set-ups to take advantage of a low volatility environment.

I want to demonstrate three trade scenarios:

-Put spread sales on VXX and UVXY

-Long VXX calls

-Long VXX diagonal spreads

The main premise of these set-ups is two-fold: A. That volatility can go higher in the next month or two due to seasonal factors, and because volatility is at the low end of the range, risk is under-priced. B. That these trades can be set up with an asymmetric risk/reward scenario; that the risk of loss is far less than the potential for gain.

Let's make a projection of VXX option prices using the negative roll formula:

(click to enlarge)

So if you believe the VIX structure will remain in this format, here are some projections for VXX and UVXY prices at future points in time taking into account the negative roll yield. In 5 trading days the VXX will be roughly 39.52, in 10 days 39.03, etc. The UVXY decays twice as fast, relative to its current price. (on volatilityanalytics.com I will be updating this frequently, and adding different term structure scenarios)

VXX Put Spreads:

Here is the VXX option chain:

(click to enlarge)

One put spread example would be to sell VXX put spreads for next week or the week after at a level that would take into account the negative roll, and gives you some wiggle room for a shift down in the VIX futures of 1 or 2 percent more. For the May 23rd expiration (May5), the VXX 38-37 put spread can be sold for roughly a .25 credit, whereas 15 days of negative roll only get you to $38.55. If the futures curve fell around 2%, that would equate to a VXX price of roughly the $38.55 less another 2% or 37.75.

Thus, it would take not only a significant drop in vol from here for this trade to lose ,but there could be no hiccup in the market during this period, else the VIX futures would rise. If the S&P saw any selling, the VXX simply cannot get to this price, and the odds are that you will keep the premium. This same method can be applied to UVXY, at say the $50-48 levels.

VXX Calls:

In the above case, your profit is capped at .25, but it you are bullish on volatility or bearish on the market, it is not a bad time to get long vol using VXX calls. As we described above, there is only so far for the VXX to fall considering how low the futures are, so you can choose some calls that don't put the entire cost of the calls at risk yet give you a ton of upside if the market sees increasing volatility or sells off:

(click to enlarge)

Again, knowing that the VXX will have a tough time falling below $38 in 20 trading days, you could purchase the May 30th VXX $37 calls for $3.35 debit. At risk over the next two weeks is realistically around $1.50 of that $3.35, but if the market sells off between now and May 30, the upside could be 100-300% of your real risk of only $1.50 per contract. It would be up to you in two weeks to reevaluate how you see the next two weeks after that playing out, and adjust accordingly, if you hadn't sold them by that point.

VXX Diagonal Spreads:

This is about as beautiful as option trades get, because you not only take advantage of rapidly decaying premium out-of-the-money, but use that to defray some of the cost of a long volatility position:

(click to enlarge)

If you suppose that this week will be a quiet one, but there are storm clouds on the horizon, you could sell the May 9th $41 call for .45 or the $41.5 call for .35 and buy the May 23rd $38 call for around $2.50. Now you are long volatility for no premium paid, essentially $2 which is the current VXX price, less the strike price of the long call, $38. Another advantage of this trade is that you can sell against it again at the end of this week to further cut into your cost of the long call. Also, if volatility rises between now and Friday, diagonal spreads benefit by rising volatility or vega.

So there are three ways to get long vol without paying high premium in VXX or VIX calls. The odds are with you on these trades, whereas buying out-of-the-money calls on the VIX and VXX as many people do is a consistent losing strategy.

(as prices have changed since publication, follow @volatilitywiz on Stocktwits or go to volatilityanalytics.com for more recent trade set-ups)

Disclosure: I am long VXX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long VXX calls and short VXX and UVXY put spreads.

During the last several weeks as the sell-off in Apple shares picked up steam, the CBOE's index of Apple volatility rose from 25 in early September, to over 44 in late October as the puts on Apple were bid high and skew developed in puts versus calls. The only higher measure was 48 in April, when Apple topped and began a $640 to $530 correction that lasted about six weeks.

Since VXAPL was created by the CBOE as a measure of Apple volatility structured similar to the VIX formula, the historical average is 32.52, almost precisely today's close. In 2012, VXAPL has averaged 31.82. By either measure, it is apparent that Apple volatility has mean reverted.

This may indicate the steep sell-off in AAPL is nearly through. The CBOE has filed with the SEC for options on the Apple VIX, similar to options on the VIX, as well as for several other stocks and ETF's, like ones holding gold and oil.

Follow our posts and trades on VolatilityAnalytics.com and on Twitter and Stocktwits at VolatilityWiz.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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